Growth stock investments are a staple of many mutual funds and aggressive portfolio strategies. These stocks are generally categorized by having higher-than-average P/E ratios, little or no dividend distributions, and faster-than-average earnings growth expectations. The premise behind this investment strategy is that the company will quickly grow into the high P/E ratio and thus bring the ratio back down over time.
One of the best ways to determine the value of a growth stock is through its price-to-earnings-to-growth (PEG) ratio. A high P/E ratio doesn’t actually mean a stock’s valuation is too expensive if the projected EPS growth rate is similarly boosted. Because fast growth is so vital to this strategy, most tend to be small or mid-cap stocks who can take advantage of economies of scale and gain market share quickly.
Upstart Holdings (UPST) is a classic example of a growth stock. It has a market cap of $6.8 billion and is engaged in developing cloud based A.I. lending platforms for financial institutions. It comes with a relatively high P/E ratio of 34 but shows a projected EPS growth rate of more than 50%.
The biggest risk to growth-oriented investment styles is that the company doesn’t grow as quickly as anticipated. A growth company that doesn’t meet expectations is often subject to a subsequent sell-off in the market as investors prioritize other more lucrative growth options. Volatility in these types of stocks tends to be higher than usual as well since changes in the economic outlook impacts future growth expectations more severely.